Northrop Grumman Corporation — Form 10-Q Summary
Business context and reporting period
Northrop Grumman provides aerospace, defense, electronics, information systems, shipbuilding, and technical services, primarily to the U.S. government and Department of Defense. This unaudited Form 10-Q covers the three and nine months ended September 30, 2010, compared with the corresponding 2009 periods. The filing was reviewed by Deloitte & Touche LLP and was not audited.
Financial performance and liquidity
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Sales and service revenues | $8.714 billion, up 4% | $26.150 billion, up 5% |
| Operating income | $801 million, up 29% | $2.282 billion, up 23% |
| Operating margin | 9.2%, versus 7.4% | 8.7%, versus 7.5% |
| Earnings from continuing operations | $489 million | $1.662 billion |
| Net earnings | $497 million | $1.677 billion |
| Diluted EPS from continuing operations | $1.64, versus $1.45 | $5.49, versus $3.67 |
| Net cash from operating activities | $978 million, versus $544 million | $1.066 billion, versus $1.202 billion |
| Free cash flow from operations | $817 million, versus $384 million | $663 million, versus $708 million |
- Product sales increased to $16.373 billion for the nine-month period, while service revenue declined slightly to $9.777 billion.
- Cash and cash equivalents were $2.528 billion at September 30, 2010, down from $3.275 billion at December 31, 2009.
- Total debt was approximately $4.2 billion, consisting of $757 million of current debt and $3.437 billion of long-term debt. The company reported no balance outstanding on its $2 billion credit agreement.
- Total assets were $30.176 billion and shareholders’ equity was $13.194 billion at September 30, 2010.
- The company repurchased 17.8 million shares for approximately $1.1 billion during the first nine months and had $1.9 billion remaining under its $2 billion authorization at quarter-end.
- Quarterly dividends increased from $0.43 to $0.47 per share. Dividends paid during the first nine months totaled $408 million.
Segment results and material changes
- Aerospace Systems: Nine-month revenue increased 8% to $8.244 billion and operating income increased 20% to $934 million. Margin improved to 11.3% from 10.2%, driven by higher volume and performance improvements.
- Electronic Systems: Revenue increased 3% to $5.740 billion and operating income increased 8% to $751 million. Margin improved to 13.1% from 12.4%.
- Information Systems: Revenue declined 1% to $6.310 billion, but operating income increased 12% to $578 million. Margin improved to 9.2% from 8.1%, including an $18 million performance improvement on the NYCWiN program.
- Shipbuilding: Revenue increased 10% to $4.989 billion, but operating income declined 9% to $191 million. Margin fell to 3.8% from 4.6% due to unfavorable performance on Expeditionary Warfare programs and the Avondale consolidation.
- Technical Services: Revenue increased 20% to $2.435 billion and operating income increased 30% to $157 million, primarily from the KC-10 and C-20 program ramp-ups.
- Total backlog was $64.647 billion at September 30, 2010, down from $69.186 billion at December 31, 2009. Funded backlog increased to $34.484 billion, while unfunded backlog declined to $30.163 billion.
- The company sold its Advisory Services Division in December 2009 for $1.65 billion. Prior-period operating results are presented as discontinued operations; 2010 discontinued-operation earnings primarily reflect purchase-price and tax adjustments.
Guidance, outlook, risks, contingencies, and unusual items
- Management stated that 2010 operating cash generation, supplemented by available borrowing capacity if needed, is expected to be sufficient to service debt, fund capital expenditures and pension contributions, repurchase shares, and pay dividends.
- The company recorded a $113 million pretax Shipbuilding charge related to winding down operations at the Avondale, Louisiana facility in 2013. It expects additional restructuring, severance, relocation, and facility shutdown costs.
- Northrop Grumman is evaluating strategic alternatives for Shipbuilding, including a possible tax-free spin-off. A Form 10 registration statement for New Ships, Inc. was filed in October 2010, but completion and benefits of any transaction are uncertain.
- The company recognized approximately $296 million of net tax benefits from the IRS settlement of 2004–2006 tax years, including $66 million in cash benefits. This materially reduced the nine-month effective tax rate to 19.9%, compared with 29.3% in 2009.
- The U.S. government was operating under a Continuing Resolution at fiscal 2010 funding levels, scheduled to expire December 3, 2010. Delayed appropriations or changes in Department of Defense procurement practices could delay awards, alter programs, or pressure margins.
- Shipbuilding continues to face quality and cost issues involving LPD-class ships, including pipe welds and propulsion-engine bearing matters. Management does not expect a material adverse effect, but additional costs remain possible.
- Environmental remediation costs were estimated at $268 million to $662 million, with $309 million accrued at September 30, 2010.
- Material legal and insurance matters include the Coast Guard Deepwater litigation, ERISA proceedings, Hurricane Katrina insurance disputes, and a Munich Re arbitration. Management generally believes these matters will not materially affect consolidated results, but outcomes are uncertain.
- Outstanding financial support arrangements included $406 million of standby letters of credit, $123 million of bank guarantees, and $453 million of surety bonds. The company also guaranteed $200 million of Shipbuilding-related bonds and a subsidiary guaranteed an additional $84 million of bonds.
Most important facts for an investor to verify
- Whether the Shipbuilding spin-off proceeds, its tax treatment is preserved, and the Avondale closure generates costs beyond current estimates.
- The composition, funding status, and conversion timing of the $64.647 billion backlog, particularly the decline in unfunded backlog.
- The sustainability of earnings after the $296 million IRS tax benefit and the effect of future effective tax rates.
- Whether Department of Defense budget, procurement, and Continuing Resolution developments affect awards, program volumes, or margins.
- Potential additional losses from Shipbuilding quality issues, contract estimate revisions, environmental remediation, and pending litigation or insurance disputes.
- Whether cash generation remains sufficient to support pension contributions, dividends, share repurchases, capital expenditures, and debt maturities while cash balances decline.